'Unprecedented' conditions stagger municipal market

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Municipal bond market participants are calling the COVID-19-led sell-off worse for the market than the aftermath of September 11th and the 2008 financial crisis combined.

The sell-off continued in the municipal market Thursday, with AAA benchmarks down by more than a half percentage point. The primary market was held at a standstill. Lipper reported more than $1.76 billion of outflows Thursday.

What is transpiring has career-long veterans of the space saying the muni market has been put in a position they’ve never seen before.

Participants don’t have room to breathe in this rapidly changing landscape and investment grade munis are suffering, being dragged down by the overall panicking in the market, with several noting that this is a liquidity-driven crisis.

“There is forced selling, impossible hedging and a pandemic,” said one Southern trader. “Uncertainty is breeding uncertainty and as usual, the bond market solution to these problems is much higher yields. This is the craziest market that I have seen — way different and way worse than 2008."

Back then, he noted, there was essentially no liquidity and large dealers were going under or about to go under. However, rates were over 5.00% on the long end and retail ultimately got back involved and stopped the bleeding. “This time, who knows,” he said.

Some said that dealers or asset managers are blowing up and indiscriminately selling. Some have been long munis and short Treasuries as a hedge and so now they’re in no other position than to get out of bonds.

"There is definitely panicking in the market, as I think managers of investment grade portfolios are anticipating stronger outflows and selling ahead of that possibility," said Robert Wimmel, head of municipal fixed income at BMO.

"We could get into an ugly cycle of negative returns begetting more outflows from panicked retail investors," he said. "However, year-to-date, the average intermediate muni fund still has a positive return. Compare that to equity markets and we don’t look so bad."

He noted that he has never seen a 50-plus basis point move.

"The biggest I can recall is 20 to 30 basis points in 2008-09, which was prompted by deleveraging of closed-end muni funds and high-yield funds," he said. "That was ugly and we were putting out sizable bid lists on a daily basis for a good week or so. But, these volatility events do open up opportunities to those with cash. We are actually using some of our liquidity to find cheap munis. That’s what we get paid to do."

Others, including Vikram Rai, head of municipal strategy at Citigroup, said it is futile to make sense of a market in panic mode.

“The most important thing to remember is that municipal spreads are widening not because investors are pricing in a deterioration in credit fundamentals but because of a liquidity crisis," Rai told The Bond Buyer. "And, we all knew that this crisis would come at some point of time given the lack of diversity in the municipal buyer base.”

He added that valuations have become more alluring.

“For years, crossover investors such as banks and insurance companies have complained that valuations in the tax-exempt space were too tight and that prices were being set by the buyer in the highest marginal tax bracket,” he said. “Well, we have gone from guard rail to guard rail in a matter of days — ratios are now well above a 100% and valuations have turned much more attractive. So, this is the time to back-up-the truck!”

One New York trader said bids-wanted line items “are looking like CVS receipts.”

“The humongous moves on the muni benchmarks are directly correlated to the redemptions we have had and investors far and wide flocking to the safe, safe, haven of Treasuries,” he said.

Some participants agreed that it is unfortunate for high-grade municipals in this sell off because they should be included in that flight to safety.

“This should be a credit-driven move, but it simply is not. The best credits should be holding some of the ‘flight to quality’ benefit, but they aren’t yet and weaker investment grade credits, even in the single-A range, will likely show some credit quality damage. The potential damage ought to be reflected in wider spreads,” said George Friedlander, of Friedlander & Associates. “So, for now, investors should join the flight to quality in munis too, with some potential real values likely to show up in high-grade muni space.”

Tom Kozlik, head of municipal strategy and credit at Hilltop Securities added that uncertainty is the name of the game right now.

"We are seeing only very small pockets of investor interest but there are also pressures out there that the market is working through now," he said. "There is an issue of price discovery at this point."

Secondary market
Munis were weaker on Thursday on the MBIS benchmark scale, with yields rising 42 basis points in the 10-year and by 30 basis points in the 30-year maturity. High-grades were also weaker, with yields on MBIS' AAA scale increasing by 40 basis points in the 10-year maturity and by 32 basis points in the 30-year maturity.

Munis weakened on Refinitiv Municipal Market Data’s AAA benchmark scale, as the yield on the 10-year muni GO was 42 basis points higher to 1.61% from 1.19% and the 30-year rose 50 basis points to 2.32% from 1.82%.

In the past two days, the yield on the 10-year has spiked by 62 basis points and the 30-year has vaulted 78 basis points, marking the biggest two day move in the history of MMD.

As far as single day moves, this marks the third biggest single day move up on the 10-year yield and the biggest ever daily move on the 30-year.

“Many of the biggest single daily cuts ever were quickly followed by bumps of equal (or greater) magnitude,” said Dan Berger, senior market strategist at TM3/MMD. “In addition, it is important to realize that most of those cuts were in the 1980s, a period of much higher interest rates. A 30 basis point move was less dramatic when interest rates were more than 8% than they would be today.”

BVAL and ICE also cut their curves, with BVAL seeing up to 46 in the 10-year and 51 in its 30-year. ICE cut its 10-year by 48 basis points and its 30-year by 51.

“Yesterday’s municipal market sell-off turned into a torrent today,” ICE Data Services said in a Thursday market note. “The ICE muni yield curve is 40 to 60 basis points higher across the curve at mid-day, an unprecedented move. High-yield bonds are being pummeled once again. Yields are up by at least 60 basis points,” ICE said. “Munis percent of Treasury yields are skyrocketing, reaching levels last seen during the financial crisis. Trade volumes are holding up, albeit at lower prices.”

The 10-year muni-to-Treasury ratio was calculated at 191.4% while the 30-year muni-to-Treasury ratio stood at 165.2%, according to MMD.

Stocks took a deep plunge on Thursday, as first thing Thursday morning the S&P 500 declined by 7%, triggering a level 1 market wide circuit breaker trading halt which commenced around 930 am.

The Dow Jones Industrial Average was down about 8.28%, the S&P 500 index was lower by 7.76% and the Nasdaq lost roughly 7.68% late in the session on Thursday. The Dow saw its worst day since the crash in 1987.

The three-month Treasury was yielding 0.303%, the Treasury two-year was yielding 0.497%, the five-year was yielding 0.648%, the 10-year was yielding 0.850% and the 30-year was yielding 1.457%.

Primary market
Although there were some small competitive sales that went off as scheduled, all larger deals that were supposed to sell or price on Thursday, have been postponed. Massachusetts pulled a multimillion competitive deal. There are currently 10 negotiated deals $100 million or larger that were supposed sell this week that are now on the day-to-day calendar.

“As an issuer, you have to go through so much trouble to postpone or pull a competitive offering,” said one New York trader. “So it makes sense that little or small deals ended up coming through, only not worth the trouble for a large offering.”

Muni money market funds see inflows
Tax-exempt municipal money market fund assets increased by $805.8 million, rising their total net assets to $134.10 billion in the week ended March 9, according to the Money Fund Report, a publication of Informa Financial Intelligence.

The average seven-day simple yield for the 187 tax-free and municipal money-market funds increased to 0.80% from 0.75% in the previous week.

Taxable money-fund assets were up $115.27 billion in the week ended March 10, bringing total net assets to $3.576 trillion. The average, seven-day simple yield for the 797 taxable reporting funds was decreased to 1.00% from 1.24% the prior week.

Overall, the combined total net assets of the 984 reporting money funds grew by $116.08 billion to $3.710 trillion in the week ended March 10.

Fed plans Treasury purchases, repurchases
The Federal Reserve Bank of New York released a new schedule of Treasury securities operations and updated its monthly schedule of repurchase agreement operations.

The N.Y Fed said the changes were being made to address liquidity issues and the “highly unusual disruptions in Treasury financing markets associated with the coronavirus outbreak.”

The terms of operations will be adjusted as needed to continue smooth Treasury market functioning and efficient and effective policy implementation, the N.Y. Fed said.

“Pursuant to instruction from the Chair in consultation with the FOMC, adjustments have been made to these schedules to address temporary disruptions in Treasury financing markets,” the N.Y. Fed said. “The Treasury securities operation schedule includes a change in the maturity composition of purchases to support functioning in the market for U.S. Treasury securities. Term repo operations in large size have been added to enhance functioning of secured U.S. dollar funding markets.”

As a part of its $60 billion reserve management, purchases for the month will start March 13 and end April 13. The Fed’s Open Market Desk will buy a range of Treasury maturities to match the maturity composition of Treasury securities outstanding. The desk plans to distribute reserve management purchases across 11 sectors, including nominal coupons, bills, Treasury Inflation-Protected Securities and floating-rate notes.

On Thursday, the desk offered $500 billion in a three-month repo operation and on Friday it will offer another $500 billion in a three-month repo operation and $500 billion in a one-month repo operation.

Three-month and one-month repo operations for $500 billion will be offered on a weekly basis for the remainder of the monthly schedule.

The desk will continue to offer at least $175 billion in daily overnight repo operations and at least $45 billion in two-week term repo operations twice a week over this period over the next month.

“This shift toward significantly larger liquidity infusions into short-term repo operations and much broader Treasury management purchases ramps up the size of the Fed’s balance sheet dramatically and takes on characteristics of quantitative easing,” said Berenberg Capital Markets Chief Economist for the U.S. Americas and Asia Mickey Levy, and U.S. Economist Roiana Reid.

“This aggressive asset-purchasing program in an array of maturities is the second emergency measure taken by the Fed in the last week,” they wrote in a market comment. “The Fed is very aware that the coronavirus and its negative economic fallout is a health crisis that cannot be addressed through monetary easing. However, in the last week, the dramatic deterioration in the corporate bond market and clear signs of illiquidity raised the Fed’s concerns that the negative health care shock was evolving into a potential financial crisis. For these reasons, the Fed acted aggressively.”

Chip Barnett and Lynne Funk contributed to this report.

Data appearing in this article from Municipal Bond Information Services, including the MBIS municipal bond index, is available on The Bond Buyer Data Workstation.

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